IMF warns war’s economic hit dwarfs natural disasters and debt defaults
New research has found that war deals a bigger blow to the economy than natural disasters or governments defaulting on their debts; Warnings also emerged that any significant increase in defense spending would require cuts to health and education services.
While a two-week ceasefire between the US and Iran has given the world economy some respite from the recent turmoil that has roiled fossil fuel markets, two reports released overnight from the International Monetary Fund point to ongoing economic tensions that will be reflected in Australia’s budget.
Australian taxpayers are already paying the costs of the Iran war, from a rise in oil and fertilizer prices to a fuel tax cut to the deployment of E-7A Wedgetail aircraft to aid the United Arab Emirates.
The IMF study examined both the long-term cost of the war and the move by many countries, including Australia, to increase their overall defense spending. It is based on the economic effects of hundreds of wars and spending booms around the world since World War II.
It found that a major war with at least 1,000 battle-related deaths resulted in a cumulative loss of 7 percent of GDP over five years. Researchers found that the economic scar of war could last more than a decade.
In comparison, the economic impact of a natural disaster is less than 6 percent, while a sovereign debt crisis, such as a country’s inability to pay its official debt, costs a country about 4.25 percent of GDP.
While wars have a long-term cost, the IMF also investigated moves by nations to increase defense spending, led by US President Donald Trump.
In Australia, the government plans to increase defense spending to 2.4 percent of GDP, while the Coalition has pledged to increase it to 3 percent.
Researchers noted that more than half of nations increased their defense budgets between 2020 and 2024. Two in five countries now spent at least 2 percent of their GDP on defense, compared to 27 percent in 2018.
Arms sales by the world’s largest arms manufacturers have doubled in real terms over the last two decades.
But the IMF said the increase in defense spending would likely put pressure on the economy through a rise in inflation, which could force the central bank to raise official interest rates, and on the government budget.
Past increases in defense spending have increased government debt by 7 percentage points over three years and led to budget deficits worsening by 2.6 percent of GDP. In Australia’s case this would mean an extra $70 billion in debt and a similarly sized increase in the deficit.
Increases in government defense spending could “crowd out” the private sector and force competition for skilled workers that would harm non-defense sectors, IMF researchers Hippolyte Balima, Andresa Lagerborg and Evgenia Weaver said.
As firms ramp up research and development, there may be some efficiency gains due to an increase in defense spending, but governments will have to cut spending to cover the extra spending in the sector, they said.
This often becomes “an exchange of guns and butter,” the trio said in a joint statement.
“The accumulation of fiscal vulnerabilities can be mitigated by resilient financing arrangements, particularly where increases in defense spending are permanent.
“But while increasing incomes comes at the expense of reducing consumption and dampening demand growth, realigning budget priorities often comes at the expense of government spending on social protection, health and education.”
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Shane Wright is senior economic correspondent for The Age and The Sydney Morning Herald.Connect with: X or email.
